Some ways to prepare yourself to deal with the financial realities of divorce – especially in this tough economy.
Often, the standard of living of both spouses drops in the first few years after divorce. Why? Because although the saying goes, “two can live as cheaply as one” , the income and assets that may have supported one household now has to support two separate households. Unfortunately, most people don’t prepare themselves financially or emotionally for that consequence. So what can you do to better prepare yourself for this inevitability? The answer is like so many things: simple, but not easy.
Here are five things you can do to help prepare yourself for your post-divorce financial future.
1. Expect your income to drop after the divorce is final.
You should expect your income to drop after the divorce is final. Develop a budget based on needs– not wants – and keep in mind that your expenses need to stay within your post-divorce income. Consider all sources of income: wages, investment income, child and spousal support (also called maintenance or alimony), keeping in mind the limited timeframe for support payments. To develop a budget, use a detailed worksheet so you don’t overlook any expenses. The best source for the expense information is your check register, if that’s how you pay your bills. Remember that not all your expenses are paid monthly; some insurance premiums or tax bills might be payable quarterly or annually, so make sure to account for those as well. To help get you started, you can use the “Monthly/Annual Expenses” worksheet; email me at: agrace@financialguide.comfor a copy.
2. Consider whether you can afford to keep the house.
Here are the traditional options for the matrimonial home:
1. One spouse stays in the house (with the children, if any) and buys the other spouse’s share by:
o Cash-out refinance
o Giving up another asset
o Property settlement note
2. The spouses sell the house during or after the divorce process and split the proceeds.
In many cases, one spouse wants to keep the house. Though this might be emotionally satisfying, it often is not financially practical. The equity in the house is illiquid, meaning it won’t pay the bills.
In today’s housing market, sometimes the home can’t be sold in a reasonable amount of time – or for a reasonable amount of money. If the house can only be sold at a loss, divorcing couples have a few options, such as:
1. Renting the house to a third party – or having one ex-spouse stay in the home and pay rent to the other until the market improves
2. “Birdnesting”: the ex-spouses retain joint ownership of the home. They also rent a small apartment nearby, and each one alternates living in the house with the kids and in the apartment on his/her own
3. Agreeing to sell the home at a loss, share the loss, and move on with their lives
4. Short-sale, foreclosure, or bankruptcy.
If one spouse wants – and can afford – to keep the house, that spouse should pre-qualify for a mortgage before the divorce is final. This is to avoid the unpleasant surprise that can come when one spouse is going to keep the house, but may get turned down for a mortgage because (s)he doesn’t qualify to refinance in his/her name alone. To qualify for a mortgage, most conventional lenders use credit scores and reports and debt- to- income ratios. Check your credit score, and talk to a mortgage broker to identify any issues before you make important decisions about the home.
3. Know what you have.
Account statements have a way of disappearing when divorce proceedings start. When contemplating divorce, start by collecting statements for all your financial holdings and put together a list of your assets. When negotiating your divorce settlement, this step will prove helpful as a starting point. Here’s an example of items you’ll need to list on an Asset Worksheet.
- Cash and investments
- Real Estate
- Personal Property
- Cash Value Life Insurance
- Business Interests
- Retirement accounts
As you work your way through the asset split negotiations, each asset can be moved to its appropriate column: “Husband” or “Wife”. To figure out the percentage split, divide the total for each spouse by the grand total.
4. Understand your financial needs.
It’s important to make sure that you factor cash flow into your calculations. Let’s suppose you want to keep the marital house – which is worth $250,000 or 40% of the marital estate – as your share of the settlement. Until you take a close look at your long-term financial forecast, you won’t know whether you can afford to keep it. Suppose, for example, you’ve factored child-support payments into your income; after the payments end, how are you going to pay the mortgage? If you have to put the house up for sale in a few years, you may be solely responsible for paying all the real-estate costs and capital-gains taxes from the time you and your spouse acquired the property until you sold it – which could be bad news indeed.
5. Hire a good team.
Personal recommendations from a trusted friend or business associate are a great source for professionals. However, you need to do your homework before hiring anyone. Your team should consist of a divorce lawyer and a Certified Divorce Financial Analyst (CDFA) at a minimum. Other members of the team could include a a therapist, a child specialist, and a business or pension valuator, and perhaps a divorce advocate. Although you may think that the more professionals you hire the more costly your divorce will be, this is not necessarily true. In the long run, having the appropriate help will cut down on litigation costs, and it may save you from making costly blunders regarding your settlement.
(UN)LUCKY SEVEN COMMON MISTAKES MADE WITH THE FINANCES OF DIVORCE
- Assuming that a 50/50 division of property is a fair settlement.
- Keeping the house when you can’t afford it.
- Failing to guarantee alimony and child support payments with life insurance on the life of the person who is suppose to pay.
- Not naming the spouse who receives alimony or child support as the owner of the life insurance policy, to help ensure that the life insurance is kept in force, unchanged.
- Looking at only the immediate short-term financial consequesnces of the divorce.
- Waiting until after the divorce to explore your health insurance options.
- Each spouse just “keeps their own” 401k plans.
